Tuesday, March 03, 2015

Let me back up a second and explain why I am revisiting this issue again. Tim Harford published an article a few days ago that took his masterful econsplaining skills to the issue of net neutrality. But in providing his characteristically clear exposition, he crystallised where many economists (including Tim) slip up on the issue of whether broadband competition would get rid of net non-neutrality and make net neutrality regulations redundant. ...

The problem here is that we believe that competition is designed to provide consumers with more of what they want. So if your claim is that they want fast and slow lanes to management network traffic, then moving from monopoly to competition won’t stop that from happening. It will likely enhance it even if, at the same time, it delivers lower prices to consumers. Indeed, in my own work (that just appeared in the Journal of Regulatory Economics), I found that it could be a vehicle for that even if net non-neutrality is not just about network management but something more sinister — like content provider hold-up.

The broader argument that I have made many times is that, in fact, solving the main problem with net non-neutrality — content provider hold-up — can be done with net neutrality while using less intrusive pricing schemes and product design to solve network management issues. In other words, I think we can have our cake and eat it too and net neutrality regulation is a good place to start.

On the issue of broadband competition, there is a political economy reason why net neutrality regulations might turn out to be bad for this: they now provide an excuse to allow things like the Comcast-Time Warner merger to proceed on the basis that net neutrality regulations curb a negative effect of that. My argument here is that I am far from convinced that the two things are related. However, I guess we will see if the political economy issues assist the merger’s regulatory chances. As Tim Harford noted, cable company stocks rose after last week’s announcement by the FCC so things are not looking too good on that front.

The unfulfilled promise of tax credits as economic policy: The relative paucity of the modern welfare state in the United States is a well-known fact among researchers. Compared to rich countries in Europe, the United States spends far less on social insurance programs and other social programs such as education. But these large disparities decrease once the private-sector side of the U.S. welfare state is included in the analysis. Yale University professor Jacob Hacker calls this the “divided welfare state,” where in many instances the U.S. tax code is now the main vehicle for social policy in retirement, college savings, and housing.

How well has this “submerged state” worked? At least in these three areas, the effectiveness of the tax code, via deductions and credits, is questionable. Consider the state of the private-sector retirement system in the United States. .... Or consider the submerged state approach to high college tuitions. ... The mortgage-interest tax deduction is another example of policy being run through the tax code. ...

To be sure, the creation of this network of tax credits and tax expenditures wasn’t without reason. Political realities necessitated the use of the tax code to achieve these ends. And these programs have done real good. But as the evidence shows, they are far from optimal.

The record of using the tax code to do tasks traditionally associated with the welfare state is clearly mixed. At best, it works like a Rube Goldberg machine that attacks a problem by hoping that a chain reaction will do the job. At worse, the machine doesn’t work for the broad majority of the population. The relevant question is now how to re-engineer it for future, more efficient use.

A key gauge of U.S. consumer prices sank in January due partly to cheaper oil, undershooting the Federal Reserve’s goal of 2% annual inflation for the 33rd consecutive month. But a gauge of underlying price pressures remained resilient headed into 2015.

The picture:

Core-PCE is hovering around 1.3%, and the stability relative to last month is supposedly supportive of Federal Reserve plans to hike interest rates later this year.

I would caution against that interpretation just yet. While it is true that the year-over-year change is how the Fed measures its progress toward price stability, you should also be watching the near term changes to see the likely direction of the year-over-year message. And in recent months, near-term core inflation has been falling at a rapid pace:

On a 3-month basis, core inflation is at its lowest since the plunge in 2008. Year-over-year inflation has been held up by a basis effect from a jump in early 2014, but unless we get another jump in the monthly data, you can guess where the year-over-year number will be heading in the next few months:

Which means that unless the numbers turn soon, there is a fairly good chance the Fed's preferred inflation guide (I say guide because headline inflation is truly the target) drifts lower as the year progresses. Hence I am less eager to embrace that today's release is supportive of the Fed's plans.

But core PCE inflation has also slowed since last summer, in part reflecting declines in the prices of many imported items and perhaps also some pass-through of lower energy costs into core consumer prices.

While oil prices have stabilized, the dollar continues to gain ground, hitting an 11-year high today:

If the dollar continues its upward gains - as might be expected given divergent monetary policy across the globe - further downward pressure on core-inflation is likely. This clearly throws a wrench into the Fed's plans. It would be hard to justify confidence in the inflation outlook if core-inflation trends lower in the months ahead.

The Fed could be headed for a very uncomfortable place. The dollar is rising, tightening financial conditions and placing downward pressure on inflation. At the same time, interest rates remain low while equities push higher, loosening financial conditions, arguably an equilibrating response to the rising dollar. On net, then, the US economy keeps grinding upward, the labor market keeps improving, and the unemployment rate sinks lower. Yellen & Co. would want to resist tightening in the face of low inflation, but they would be increasingly tempted to react to low unemployment. Moreover, concerns of financial instability would mount if longer-term rates remained low and equities pushed higher. All in all, sounds like an increasingly hawkish FOMC coupled with a sluggish global economy and dovish central bankers elsewhere is raising the odds of a US policy error.

Bottom Line: The rising dollar may be causing the Fed more headaches than they like to admit. To the extent that it is pushing inflation lower, the dollar should be delaying the time to the first rate hike as well as lowering the subsequent path of rates. The Fed may have to respond to the so-called "currency wars" whether they like it or not. That said, I can't rule out that they ignore the inflation numbers given the tightening labor market and what they perceive to be loose financial conditions. The Fed could fail to see the precarious nature of the current environment and move forward with plans to normalize policy. Increasingly likely to be a very interesting summer for monetary policy.

Monday, March 02, 2015

Is income inequality harmful?, The Good Society, March 2015: A generation ago, perhaps even just a few years ago, worry about high or rising income inequality stemmed mainly from a belief that it is unfair. In recent years the source of apprehension has shifted. The dominant concern now is that inequality may have harmful effects on a range of outcomes we value, from education to health to economic growth to happiness to democracy and more. Does it?

My answer is organized as follows:

How should we assess income inequality’s effects?

Education

Health

Family

Safety

Residential mixing

Trust

Economic growth

Employment

Economic stability

Household income growth: the poor

Household income growth: the middle class

Household balance sheets

Equality of opportunity

Happiness

Democracy

Is income inequality harmful?

What should we do?

One hypothesis of interest for some of these outcomes is that a higher level of income inequality increases inequality in the outcome. For instance, we might expect greater income inequality to contribute to greater inequality between the rich and the poor in life expectancy or happiness.

A second hypothesis is that a higher level of income inequality worsens the aggregate level of an outcome. For example, greater income inequality might reduce the average life expectancy or average happiness in a country.

Third, for some outcomes the hypothesis is that a higher level of income inequality worsens change in the aggregate level of an outcome. Greater income inequality might, for instance, reduce a country’s economic growth (change in per capita GDP) or median household income growth.

How Should We Assess Income Inequality's Effects?

The most informative test, which I’ll use here, is to see whether changes in income inequality in the world’s rich countries correlate with changes in the various outcomes. It’s important to understand why this analytical approach is useful, so bear with me for a moment while I elaborate. ...

After many, many paragraphs of analysis of the points listed above (including figures illustrating important points), he concludes:

Should we worry about high and rising income inequality in the United States? My answer is yes, for three reasons.

First, we have good evidence that income inequality tends to reduce middle-class income growth, increase disparities in education, health, family structure, and happiness, and heighten residential segregation. Not everyone will find these consequences objectionable, but I do.

Second, although we don’t have strong evidence that the rise in income inequality over the past generation has increased inequality of political influence, there’s good reason to fear that it has. That would be an intrinsically bad thing; it’s antithetical to what most of us understand to be the core of democracy — government by and for all of the people, not just some of the people. In addition, if rising income inequality does increase the political influence of the rich, that could potentially have harmful spillover effects on a variety of outcomes in the future.

Third, the level of income inequality that currently obtains in the United States is unfair. Given that luck plays a huge role in determining the income people end up with, much of the disparity in incomes is, arguably, undeserved. Most of us accept some amount of income inequality as consistent with a reasonable degree of freedom and needed to sustain a dynamic, healthy economy. But the degree of inequality in the contemporary US surely is past that point.

That said, reducing income inequality isn’t likely to be easy or quick. And income inequality’s apparently small or nonexistent impact on many of the outcomes examined here suggests that it shouldn’t necessarily be at the forefront of policy goals. For many of these outcomes, from education to health to economic growth and more, a direct approach, rather than an indirect one that works via reduced income inequality, is likely to be the most successful path.

Walmart’s Visible Hand, by Paul Krugman, Commentary, NY Times: A few days ago Walmart, America’s largest employer, announced that it will raise wages for half a million workers. For many of those workers the gains will be small, but the announcement is nonetheless a very big deal, for two reasons. First, there will be spillovers: Walmart is so big that its action will probably lead to raises for millions of workers employed by other companies. Second, and arguably far more important, is what Walmart’s move tells us — namely, that low wages are a political choice, and we can and should choose differently.

Some background: Conservatives — with the backing, I have to admit, of many economists — normally argue that the market for labor is like the market for anything else. The law of supply and demand, they say, determines the level of wages, and the invisible hand of the market will punish anyone who tries to defy this law.

Specifically,... a minimum wage, it’s claimed, will reduce employment and create a labor surplus... Pressuring employers to pay more, or encouraging workers to organize into unions, will have the same effect.

But labor economists have long questioned this view..., workers are people, wages are not, in fact, like the price of butter, and how much workers are paid depends as much on social forces and political power as it does on simple supply and demand. ...

Walmart is ready to raise wages.... And its justification for the move echoes what critics of its low-wage policy have been saying for years: Paying workers better will lead to reduced turnover, better morale and higher productivity.

What this means, in turn, is that engineering a significant pay raise for tens of millions of Americans would almost surely be much easier than conventional wisdom suggests. Raise minimum wages by a substantial amount; make it easier for workers to organize, increasing their bargaining power; direct monetary and fiscal policy toward full employment, as opposed to keeping the economy depressed out of fear that we’ll suddenly turn into Weimar Germany. It’s not a hard list to implement — and if we did these things we could make major strides back toward the kind of society most of us want to live in.

The point is that extreme inequality and the falling fortunes of America’s workers are a choice, not a destiny imposed by the gods of the market. And we can change that choice if we want to.

The highlight of the week was Federal Reserve Chair Janet Yellen's testimony to the Senate and House. On net, I think her assessment of the US economy was more optimistic relative to the last FOMC statement, which gives a preview of the outcome of the March 17-18 FOMC meeting. Labor markets are improving, output and production are growing at a solid pace, oil is likely to be a net positive, both upside and downside risks from the rest of the world, and, after the impact of oil prices washes out, inflation will trend toward the Fed's 2% target. To be sure, some challenges remain, such as still high underemployment and low levels of housing activity, but the overall picture is clearly brighter. No wonder then that the Fed continues to set the stage for rate hikes this year. Importantly, Yellen gave the green light for pulling "patient" at the next FOMC meeting:

If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee's judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting.

She is under pressure from both hawks and moderates to leave June open for a rate hike, which requires pulling "patient" from the statement. But at the same time, they don't want the end of "patient" to be a guarantee of a rate hike in June. And that is the message Yellen sends here.

More broadly, though, Yellen is signaling the end of extensive forward guidance. They don't know how the data will unfold at this point, so they are no longer willing to guarantee one particular monetary policy path or another. This was also the message sent by Federal Reserve Vice Chair Stanley Fischer. Via the Wall Street Journal:

Mr. Fischer said that while many believe the Fed will move rates steadily higher, meeting by meeting, in modest increments, it is unlikely the world will allow that to happen. “I know of no plans to follow one of those deterministic paths,” he said, adding, “I hope that doesn’t happen, I don’t believe that will happen.”

Instead, Mr. Fischer affirmed that whatever the Fed does with short-term rates will be determined by the performance of the economy, which will almost certainly offer the unexpected.

Mr. Fischer said there is value in making sure you don’t take markets “by surprise on a regular basis.” But at the same time, offering too much guidance can shackle monetary policy makers, and “there’s no good reason to telegraph every action.”

It's "game on" for Fed watchers! Figure it out, because the Fed will no longer be holding our hands.

Separately, San Francisco Federal Reserve President John Williams echoes Yellen's assessment of the US economy. Via the Wall Street Journal:

In an interview with The Wall Street Journal, Mr. Williams expressed a good deal of confidence in the U.S. outlook, especially on hiring. He said the jobless rate could fall to 5% by the end of the year, which means the central bank is getting closer to boosting its benchmark short-term interest rate from near zero, where it has been since the end of 2008.

“We are coming at this from a position of strength,” Mr. Williams said. “As we collect more data through this spring, as we get to June or later, I think in my own view we’ll be coming closer to saying there are a constellation of factors in place” to make a call on rate increases, he said.

He also gives guidance on why the Fed will soon be confident that inflation will trend back toward target. It's all about the labor market:

Mr. Williams said it is likely that the Fed will see a hot labor market that should in turn produce the wage pressures that will drive inflation back up to desired levels. He said much of the weakness seen now in price pressures is due to the sharp drop in oil prices, which he said isn’t likely to last.

“The cosmological constant is that if you heat up the labor market, get the unemployment rate down to 5% or below, that’s going to create pressures in the labor market” causing wages to rise, he said.

Williams also bemoans the failure of financial market participants to, as he sees it, catch a clue:

Mr. Williams said there is a “disconnect” between Fed officials’ and markets’ expectations for the path of short-term rates. He said he hopes that can be bridged by effective communication explaining central bank policy choices.

St. Louis Federal Reserve President James Bullard has often stated the same concern, and does so again in yet another interview with the Wall Street Journal:

Mr. Bullard said he is worried financial markets aren’t fully taking on board the likely path of monetary policy, and are underpricing what the Fed will do with interest rates.

“The market is pricing in a later and slower and shallower pace of increases” compared to what central bankers think, the official said. “The mismatch has to get resolved at some point, and I think there’s some risk it could be resolved in a violent way,” which he suspects no one would like to see.

Similarly, New York Federal Reserve President William Dudley warns that the Fed will need to choose a more aggressive rate path if financial market participants don't figure it out after the Fed starts raising rates:

As an example, one significant conundrum in financial markets currently is the recent decline of forward short-term rates at long time horizons to extremely low levels—for example, the 1-year nominal rate, 9 years forward is about 3 percent currently. My staff’s analysis attributes this decline almost entirely to lower term premia. In this case, the fact that market participants have set forward rates so low has presumably led to a more accommodative set of financial market conditions, such as the level of bond yields and the equity market’s valuation, that are more supportive to economic growth. If such compression in expected forward short-term rates were to persist even after the FOMC begins to raise short-term interest rates, then, all else equal, it would be appropriate to choose a more aggressive path of monetary policy normalization as compared to a scenario in which forward short-term rates rose significantly, pushing bond yields significantly higher.

All of which sounds to me like the Fed wants to see the term premium start drifting higher - in other words, the situation is now the opposite of the unintended climb in term premiums during the 2013 "Taper Tantrum" incident.

When will that first hike occur? Far too much attention is placed on that question says Fischer:

He said there has been “excessive attention” paid to the issue of when rates will be lifted, and not enough to attention to what happens with short-term rates once they’ve been boosted off of their current near-zero levels.

That I suspect is correct; I am more interested in how the Fed proceeds after the first rate hike (June still on the table, but I don't know if they will have sufficient data to be confident in the inflation outlook) than the timing of the rate hike itself. Is the Fed really as eager to challenge financial markets as Dudley suggests? I am a little nervous this is shaping up to be a repeat of the Riksbank incident.

Bottom Line: The Fed's confidence in the US economy is driving them closer to policy normalization. The labor market improvements are key - as long as unemployment is falling, confidence in the inflation outlook is rising. The more important message, however, is as the timing of the first rate hike draws closer, the level of uncertainty is rising. And it is not just about the timing of that rate hike. The Fed is sending a clear message that the subsequent path of rates is also very uncertain, and they don't think that uncertainty is being taken seriously by market participants. In their view, financial markets are too complacent about the likely path of interest rates.

Sunday, March 01, 2015

What is the new normal for the real interest rate?: The yield on a 10-year Treasury inflation protected security was negative through much of 2012 and 2013, and remains today below 0.25%. Have we entered a new era in which a real rate near zero is the new normal? That’s the subject of a new paper that I just completed with Ethan Harris, head of global economics research at Bank of America Merrill Lynch, Jan Hatzius chief economist of Goldman Sachs, and Kenneth West professor of economics at the University of Wisconsin...

For the project we assembled annual data on the interest rate set by the central bank (or close substitute) along with inflation estimates for 20 different countries going back in some cases to 1800, along with more detailed quarterly data since 1970. ...

We found little support in these data for two of the popular conceptions many people have about real interest rates. First, although it is often assumed in theoretical models that there is some long-run constant value toward which the real interest rate eventually returns, our long-run data lead us to reject that hypothesis, consistent with other studies...

We also found little support for the popular assumption that the long-run economic growth rate is the primary factor driving changes in the equilibrium real interest rate over time. ...

We conclude that changes in personal discount rates, financial regulation, trends in inflation, bubbles and cyclical headwinds have had important effects on the average real rate observed over any given decade. We examine the secular stagnation hypothesis in detail. On balance, we find it unpersuasive, concluding that it confuses a delayed recovery with chronically weak aggregate demand. ...

It’s worth remembering that recoveries from financial crises often take many years. ... Our paper reviews a great deal of evidence that leads us to conclude that those who see the current situation as a long-term condition for the United States are simply over-weighting the most recent data from an economic recovery that is still far from complete...

Finally, our paper discusses the implications of these findings for monetary policy. ... We conclude that, given that we do not know the equilibrium real rate, there may be benefits to waiting to raise the nominal rate until we actually see some evidence of labor market pressure and increases in inflation. ...

First, any attempt to estimate the impact of a policy change on G.D.P. requires an economic model. Because reasonable people can disagree about what model, and what parameters of that model, are best, the results from dynamic scoring will always be controversial. ...

Third, dynamic scoring matters most over long time horizons. Some policy changes, such as those aimed at encouraging capital investments, take many decades to have their full impact on economic growth. Yet congressional budgeting usually looks only five or 10 years ahead. ...

So there are good reasons for the economists hired by Congress to pursue dynamic scoring. But there are also good reasons to be wary of the endeavor. ...

Another worry is the politicization of the CBO. See here and here. Also see here and here on the application of dynamic scoring to things such as Head Start and infrastructure spending.

First, any attempt to estimate the impact of a policy change on G.D.P. requires an economic model. Because reasonable people can disagree about what model, and what parameters of that model, are best, the results from dynamic scoring will always be controversial. Just as many Republicans are skeptical about the models of climatologists when debating global warming, many Democrats are skeptical about the models of economists when debating tax policy.

My read of the article was going just fine until the climate model analogy. Two assumptions are made:

All economists agree on "the models of economists"

Reasonable people can disagree about climatology models

In terms of #1, there is significant disagreement amongst economists about macroeconomic models (i.e., have you read Krugman lately?). In terms of #2, science is different than social science. Climatology involves forecasts so it is different than tests of the law of gravity, but still, ninety-x percent of climate scientists agree. That is a bit higher than the number of economists who agree on anything macro.

My stance is that we should accept that the earth is likely warming and people contribute to it (even the U.S. Senate, including those Republicans that Mankiw mentions [did he miss that vote?], overwhelming thinks so). That moves us to the debate on whether we should do anything it or learn to adapt. I think that reasonable people can disagree on that second question.

Friday, February 27, 2015

Credit supply and the housing boom: ... Conclusion In this column, we argued that any reconstruction of the fundamental causes of the housing and credit boom that preceded the Great Recession must be consistent with four stylised facts: house prices and debt surged, the ratio of debt to house values was roughly constant, and real mortgage rates fell. From the perspective of these four facts, explanations that rely exclusively on an increase in credit demand associated with more generous credit conditions—for instance in the form of higher loan-to-value ratios—are lacking. On the contrary, a shift in credit supply associated with the emergence of securitisation and shadow banking, is qualitatively and quantitatively consistent with the four facts.

This interpretation of the macroeconomic facts has the additional merit of being consistent with the micro-econometric evidence of Mian and Sufi (2009 and 2010). They show that an expansion in credit supply was the fundamental driver of the surge in household debt, and that borrowing against the increased value of real estate accounts for a significant fraction of this build-up in debt.

Shifting the focus of the inquiry into the causes of the boom from credit demand to credit supply has potentially important implications for the study of macro-prudential policy, since much of the literature on this topic has tended to model the boom as stemming from looser borrowing constraints. Exploring the normative implications of the alternative view proposed in this article is an exciting avenue for future research.

Well, if you were to believe many of the news reports and opinion pieces of the past few days, you’d think that it was a disaster... Some factions within Syriza apparently think so, too. But it wasn’t. ... Greece came out of the negotiations pretty well, although the big fights are still to come. ...

To make sense of what happened, you need to understand that the main issue of contention involves just one number: the size of the Greek primary surplus, the difference between government revenues and government expenditures not counting interest on the debt. The primary surplus measures the resources that Greece is actually transferring to its creditors. ...

Syriza has always been clear that it intends to keep running a modest primary surplus. If you are angry that the negotiations didn’t make room for a full reversal of austerity, a turn toward Keynesian fiscal stimulus, you weren’t paying attention.

Why would any government agree to such a thing? Fear ... that the creditors would cut off their cash flow or, worse yet, implode their banking system if they balked at ever-harsher budget cuts.

So did the current Greek government back down and agree to aim for those economy-busting surpluses? No, it didn’t. In fact, Greece won new flexibility for this year, and the language about future surpluses was obscure. ... And the creditors ... made financing available to carry Greece through the next few months. ...

Why, then, all the negative reporting..., nothing that just happened justifies the pervasive rhetoric of failure. Actually, my sense is that we’re seeing an unholy alliance here between left-leaning writers with unrealistic expectations and the business press, which likes the story of Greek debacle because that’s what is supposed to happen to uppity debtors. But there was no debacle. Provisionally, at least, Greece seems to have ended the cycle of ever-more-savage austerity..., the first real debtor revolt against austerity is off to a decent start, even if nobody believes it. What’s the Greek for “Keep calm and carry on”?

11:30 am Daniel Greenwald, New York UniversityMartin Lettau, University of California at Berkeley and NBERSydney Ludvigson, New York University and NBEROrigins of Stock Market Fluctuations Discussant: John Cochrane, University of Chicago and NBER

Thursday, February 26, 2015

Research by Jaumotte and Carolina Osorio Buitron of the IMF finds that "The decline in unionization in recent decades has fed the rise in incomes at the top":

Power from the People: Inequality has risen in many advanced economies since the 1980s, largely because of the concentration of incomes at the top of the distribution. ...

While some inequality can increase efficiency by strengthening incentives to work and invest, recent research suggests that higher inequality is associated with lower and less sustainable growth in the medium run (Berg and Ostry, 2011; Berg, Ostry, and Zettelmeyer, 2012), even in advanced economies (OECD, 2014). Moreover, a rising concentration of income at the top of the distribution can reduce a population’s welfare if it allows top earners to manipulate the economic and political system in their favor (Stiglitz, 2012). ...

We examine the causes of the rise in inequality and focus on the relationship between labor market institutions and the distribution of incomes, by analyzing the experience of advanced economies since the early 1980s. ... [W]e find strong evidence that lower unionization is associated with an increase in top income shares in advanced economies during the period 1980–2010 (for example, see Chart 2)... This is the most novel aspect of our analysis, which sets the stage for further research on the link between the erosion of unions and the rise of inequality at the top. ...

Can helicopter money be democratic?: Helicopter money started as an abstract thought experiment..., in technical terms this is a combination of monetary policy (the creation of money) and fiscal policy (the government giving individuals money). Economists call such combinations a money financed fiscal stimulus. With the advent of Quantitative Easing (QE), it has also been called QE for the people.

Some have tried to suggest that central banks could undertake helicopter money for the first time without the involvement of governments. This is a fantasy that those who dislike the idea of government have concocted. Others who dislike the idea of fiscal policy have suggested that helicopter money is not really a fiscal transfer. That is also nonsense. ...

If initiation by the central bank is the defining feature of helicopter money, and this policy always requires the cooperation of government, might it be possible to imagine a form of helicopter money that was more ‘democratic’? ... A left wing government might decide that, rather than giving money to everyone including the rich, it would be better to increase transfers to the poor. A right wing government might decide it should only go to ‘hard working families’, and turn it into a tax break. We could call this democratic helicopter money.

I can see two problems with democratic helicopter money. ...

Given these problems, why even think about democratic helicopter money? One reason may be political. A long time ago I proposed giving the central bank limited powers to make temporary changes to a small set of predefined tax rates, and I found myself defending that idea in front of the UK’s Treasury Select Committee. To say that the MPs were none too keen on my idea would be an understatement. Making helicopter money democratic may be what has to happen to get politicians to support the idea.

Making Do with More: If we as a species can avoid nuclear war; curb those among us who are violent because they are God-maddened, state-maddened, or ethnicity-maddened; properly coordinate global action to reduce global warming from its current intolerable projected path to a tolerable one, adapt to the global warming that occurs, and distribute paying for the costs of that adaptation--well, if we can do all of those things, the human race can have a very bright future indeed. ...

Is competition to attract businesses harmful?: State and local governments often use incentives such as tax cuts, rebates, promises of government services and the easing of regulatory restrictions to induce new or existing businesses to locate in their region.

But this strategy raises some important questions:

Do these policies work

Do the costs exceed the benefits?

Do the policies simply redistribute economic activity from one region to another, what economists call a "zero-sum game," or do they create a positive aggregate effect from easing tax burdens and other restrictions?

Finally, if it is a zero-sum game, would the U.S. benefit from banning this sort of competition for businesses at the state and local level because it lowers the tax revenue needed to fund critical services and erodes regulatory protections?

What happened to shared growth? Most economists continue to explain the explosion of earnings inequality with conventional supply-and-demand stories, in which worker compensation is believed to accurately reflect the contribution workers make to production. Thus, in this view, CEOs and financiers have received skyrocketing salaries, especially since the mid-1990s, because they are now contributing dramatically more to their firms and to the economy as a whole.

Similarly, the bottom 90 percent have seen stagnant and falling wages because they’ve fallen behind in the “race between education and technology.” The computerization of the workplace requires greater cognitive skills, but workers have not kept up, as indicated by the slowdown in college graduation rates. Assuming (nearly) perfectly competitive markets, the explosion in wage inequality in this view must reflect a similarly explosive increase in skill mismatch (too many low skill workers, too few high skill ones).

Such arguments leave little or no room for labor market institutions and public policies in the determining changes in the distribution of earnings up and down the income ladder. An alternative view is that institutionally-driven bargaining power is a critical piece of the story, whether it is the noncompetitive “rents” earned by top managers and financiers, or the collapsing power of hourly wage employees. As Thomas Piketty argues in “Capital in the Twenty-First Century:”

In order to understand the dynamics of wage inequality we must introduce other factors, such as the institutions and rules that govern the operations of the labor market in each society [and explain] the diversity of wage distributions we observe in different countries at different times.

All rich countries face challenges from technology and globalization, but only the United States and the United Kingdom show inequality rising to extreme levels.

In order to understand wage inequality and unshared productivity growth in the United States, we must take a much closer look at the ways in which institutions affect labor market outcomes. ...

Mr. Autor’s latest paper, presented to a packed audience at this year’s meeting of central bankers at Jackson Hole, Wyo., emphasized how difficult it is to program machines to do many tasks that humans find often easy and intuitive. In it, he played off a paradox identified in the 1960s by philosopher Michael Polanyi, who noted that humans can do many things without being able to explain how, like identify the face of a person in a series of photographs as they age. Machines can’t do that, at least not with accuracy.

This is why big breakthroughs in automation will take longer than many predict, Mr. Autor told the bankers. If a person can’t explain how they do something, a computer can’t be programmed to mimic that ability. ...

To Mr. Autor, polarization of the job market is the real downside of automation. He calculates middle-skill occupations made up 60% of all jobs in 1979. By 2012, this fell to 46%. The same pattern is visible in 16 European Union economies he studied.

The upshot is more workers clustered at the extremes. At the same time, average wages have stagnated for more than a decade. He attributes this to the loss of all those relatively good-paying middle-range jobs, as well as downward pressure on lower-skilled wages as displaced workers compete for the lesser work. ...

I've been arguing for a long time that in coming decades the major question will be about distribution, not production. I'm not very worried about stagnation, etc. -- we'll have plenty of stuff to go around. I'm worried about, to quote the title of a political science textbook I used many, many, many years ago as an undergraduate, "who gets the cookies?" not how many cookies we're able to produce So I agree with Autor on this point:

Mr. Autor ... added, “If we automate all the jobs, we’ll be rich—which means we’ll have a distribution problem, not an income problem.”

The cost of delaying action to stem climate change: A meta-analysis, Vox EU: Summary The cost of delaying climate action has been studied extensively. This column discusses new findings based on a meta-analysis of published model runs. A one-decade delay in addressing climate change would lead to about a 40% increase in the net present value cost of addressing climate change. If anything, the methodology used in this analysis could understate the cost of delay. Uncertainty and the possibility of tipping points provide a motivation for more action as a form of insurance against worse outcomes.

What's a fair tax rate? It depends: How progressive should the U.S. tax system be? Answering this question requires an assumption about what's fair in terms of tax burdens across income groups. But people differ widely on what they consider fair. Therefore, fairness isn't something economic theory can address. Instead, a principle of fairness must be assumed.

First, I think that monetary policymakers should not be looking at potential output and the output gap at all. They should be looking at the labor market. ...[graph 1, graph 2]

Second, I think that the most important macroeconomic research question of our age is the extent to which these fluctuations in the projected growth path arise because of signal-processing considerations in an environment in which the growth rate is subject to both transitory and permanent shocks, rather than to short-run shocks casting very long-run shadows. To the extent that it is the second–and the older I get the more it looks to me as though it might well be–the more it becomes the case that successful management of aggregate demand and the business cycle is the ball game, rather than just being an amuse bouche that it is nice to have.

Third, there is the question that I now harp upon incessantly of the relationship between measured real GDP and money-metric utility in a consumer-surplus sense. (Plus there is the question of the relationship between money-metric utility in a consumer surplus sense and societal well-being.)

Fourth, I question whether previous pre-1980 studies of the U.S. economy would reveal similar fluctuations in trend growth projections. In fact, as best as I can determine, it does not. Going back to the start of the 1890s, at least, and even with such enormous shocks as the Great Depression and World War II, straightforward projections of real GDP do not fluctuate nearly as much as those that have been made over the last twenty years...[graph 3] ... Is this an illusion? Accidental overlapping and offsetting shocks that just happened to sum to zero? It may well be...

Social Security is much more than a retirement program. It pays modest but guaranteed benefits when someone with a steady work history dies, retires, or becomes severely disabled. Although nobody likes to think that serious sickness or injury might knock them out of the workforce, a young person starting a career today has a one-third chance of dying or qualifying for DI before reaching Social Security’s full retirement age. ...

DI’s eligibility criteria are strict (...most applications are denied) and its benefits modest..., on average, only about half of their lost earnings... DI beneficiaries are far likelier to be poor or near-poor than other Americans. ... And at age 66, DI beneficiaries are seamlessly switched to retirement benefits without filing a fresh application. ...

Despite ... close links, the disability program’s trust fund is separate from the retirement and survivor program. There’s no longer any good reason for that — the 1979 Advisory Council recommended a merger of the trust funds — but lawmakers instead have relied on periodic reallocations of tax revenue between the two programs to shore up whichever trust fund needed it. They need to do so again to prevent a sudden, 20-percent cut in payments to vulnerable DI beneficiaries in 2016.

The need to replenish DI isn’t a crisis, nor would reallocating simply “kick the can down the road” as some contend. Instead it’d allow lawmakers to focus on the real task: assembling a package of revenue increases and modest benefit reforms to preserve long-term solvency for all of Social Security. Americans of all ages and incomes support Social Security and are willing to pay for it.

Monday, February 23, 2015

If China Stops Manipulation, Its Currency Will Depreciate: A rare issue on which the two parties in the US Congress agree is the problem of “currency manipulation,” especially on the part of China. Perhaps spurred by the 2014 appreciation of the dollar and the first signs of a resulting loss of American net exports, Congress is once again considering legislation to attack currencies that are seen as unfairly undervalued. The proposed measures include the threat of countervailing duties against imports from offending countries, although that would be inconsistent with international trading rules.

Even if one accepts the possibility of identifying a currency that is manipulated, however, China no longer qualifies. Under recent conditions, if China allowed its currency to float freely, without intervention, the renminbi would more likely depreciate against the dollar than appreciate. US producers would then find it harder to compete on international markets, not easier. ...

Even Better Than a Tax Cut: With the early stages of the 2016 presidential campaign underway and millions of Americans still hurting financially, both parties are looking for ways to address wage stagnation. That’s the good news. The bad news is that both parties are offering tax cuts as a solution. What has hurt workers’ paychecks is not what the government takes out, but what their employers no longer put in — a dynamic that tax cuts cannot eliminate. ...

Yes, a one-time reduction in taxes through, say, expanded child care credits or a secondary earner tax break, as Democrats propose, could help families. But as wages continue to stagnate, it is impossible to continuously cut taxes and still pay for things like education and social programs for the growing population of older Americans. ...

Contrary to conventional wisdom, wage stagnation is not a result of forces beyond our control. It is a result of a policy regime that has undercut the individual and collective bargaining power of most workers. Because wage stagnation was caused by policy, it can be reversed by policy, too.

Knowledge Isn’t Power, by Paul Krugman, Commentary, NY Times: ... Just to be clear: I’m in favor of better education. Education is a friend of mine. And it should be available and affordable for all. But ... people insisting that educational failings are at the root of still-weak job creation, stagnating wages and rising inequality. This sounds serious and thoughtful. But it’s actually a view very much at odds with the evidence, not to mention a way to hide from the real, unavoidably partisan debate.

The education-centric story of our problems runs like this: We live in a period of unprecedented technological change, and too many American workers lack the skills to cope with that change. This “skills gap” is holding back growth, because businesses can’t find the workers they need. It also feeds inequality, as wages soar for workers with the right skills... So what we need is more and better education. ...

It’s repeated so widely that many people probably assume it’s unquestionably true. But it isn’t..., there’s no evidence that a skills gap is holding back employment...

Finally, while the education/inequality story may once have seemed plausible, it hasn’t tracked reality for a long time..., the inflation-adjusted earnings of highly educated Americans have gone nowhere since the late 1990s.

So what is really going on? Corporate profits have soared as a share of national income, but there is no sign of a rise in the rate of return on investment..., it’s what you would expect if rising profits reflect monopoly power rather than returns to capital... — all the big gains are going to a tiny group of individuals holding strategic positions in corporate suites or astride the crossroads of finance. Rising inequality isn’t about who has the knowledge; it’s about who has the power.

Now, there’s a lot we could do to redress this inequality of power. We could levy higher taxes on corporations and the wealthy, and invest the proceeds in programs that help working families. We could raise the minimum wage and make it easier for workers to organize. It’s not hard to imagine a truly serious effort to make America less unequal.

But given the determination of one major party to move policy in exactly the opposite direction, advocating such an effort makes you sound partisan. Hence the desire to see the whole thing as an education problem instead. But we should recognize that popular evasion for what it is: a deeply unserious fantasy.

Yellen Heading to the Senate, by Tim Duy: All eyes will be focused on Federal Reserve Chair Janet Yellen as she presents the semi-annual monetary policy testimony to the Senate Banking Committee. I anticipate that she will stick to an economic outlook very similar to that detailed in the last FOMC statement and related minutes. Expect her to indicate that the Fed is closing in on the time of the first rate hike - after all, this was clearly the topic of conversation at the January FOMC meeting. I anticipate the "Audit the Fed" movement will be on display in the Q&A, which will provide Senators the opportunity to display their ignorance of monetary policy. And with any luck, we will learn how "patient" the Fed really is.

That said, I am wary of expecting much in the way of insight on "patient." The Fed has trapped itself with that language, and I am thinking that it will take the collective power of the FOMC to devise a way out. And they have little choice but to deal with that issue at the March FOMC meeting. The basic problem is this: The hawks would be happy with pulling the trigger on 25bp at the March meeting. The center isn't ready to go along with that, but they want the option of being able to pull the trigger in June. But Yellen, in trying to signal in December that a rate hike was not imminent, linked the term "patient" to two meetings. So if they keep "patient" in the statement, it seems to imply that June is off the table, but that message will brings squeals of unhappiness from the hawks and even leave the center uncomfortable. But just pulling "patient" risks leaving the impression that a June hike is a certainty, which is a message the center doesn't want to send.

If you think this is a dumb way to manage monetary policy, you are correct. Now that the Fed is closer to meeting their employment mandate, they simply cannot credibly signal intentions six months in advance. They need to let the data start doing the work for them, but don't know how to make that transition.

It something of a shame that Yellen couldn't leave well enough alone in December and let financial market participants believe that "patient" would be used as it had been in 2004. In that case, "patient" would have no time horizon other than that dropping the word "patient" meant that a rate hike was likely just one meeting away. They could credibly manage such a signal. Anything more than one meeting ahead is problematic.

On the economic outlook, I would say that if Yellen were to deviate from the January FOMC meeting, it would be in a generally positive direction. I think they will take the subsequently released upbeat employment report as strong evidence that underlying trends remain solid. The news that Wal-Mart is raising salaries will likely be viewed as just the tip of the iceberg. I doubt anyone on the FOMC believes Wal-Mart leadership acted out of the kindness of their hearts. Yellen herself will probably think something to the effect that "I told you that the quits rate was important."

Assuming the Greece situation holds together for another 24 hours, that coupled with easing by global central banks in recent weeks will lead FOMC members to believe that global risks have dissipated. And to top it off, US equities pushed back to record highs. What's not to like? Maybe the GDP numbers, but Cleveland Federal Reserve President Loretta Mester gave what I think is the consensus view on the topic:

WSJ: Putting aside the tailwinds that you’re seeing. The growth data look a little soft at the moment.

MESTER: Not really. The fourth quarter came in after two quarters of really robust growth. The employment report actually was revised up for those last couple of months. There is this tendency to look at the last data point. I’m just not that concerned. I think we’ve seen growth pickup. I think there is more momentum in the economy.

Hence why I also don't agonize about what a snowstorm means for monetary policy. It means nothing.

There is plenty on the docket beyond Yellen this week. Existing and new home sales, consumer confidence, regional Fed manufacturing indexes, durables goods orders, CPI, Case-Shiller, GDP revisions, and, if that weren't enough, speeches by Fed Presidents of Atlanta (Lockhart), Cleveland (Mester), and New York (Dudley), and Federal Reserve Governor Stanley Fischer. The fun just won't stop!

Bottom Line: I expect the Fed will continue to walk the fine line between keeping June in play while signaling that the data will soon justify a rate hike though not necessarily in June. And watch for signs of an effort to shift the focus to the expected gradual pace of rate hikes in an effort to minimize adverse market reaction to the possibility of June. Expect generally positive views of recent data; the Fed thinks the economy is finally on the right path.

Sunday, February 22, 2015

Helicopter money and the government of central bank nightmares: If Quantitative Easing (QE), why not helicopter money? We know helicopter money is much more effective at stimulating demand. Helicopter money is a form of what economists call money financed fiscal stimulus (MFFS). In their current formulation independent central banks (ICB) rule out MFFS, because the institution that can do the stimulus (the government) is not allowed to cooperate on this with the institution that creates money (the ICB). In a world where governments - through ignorance or design - obsess about deficits when they should not, it turns out that MFFS or helicopter money is all we have left to prevent large negative demand shocks leading to deep and prolonged recessions. So why is it taboo?

One reason why it is taboo among central banks is that they want an asset that they can later sell when the economy recovers. QE gives them that asset, but helicopter money does not. The nightmare (as ever with ICBs) is not the current position of deficient demand, but a potential future of excess inflation that they are unable to control. .... Helicopter money ... puts money into the system at the ZLB, in a much more effective way than QE, but it cannot be put into reverse by central banks alone. The central bank cannot demand we pay helicopter money back. [4]

If the government cooperates, this is no problem. The government just ‘recapitalises’ the central bank, by either raising taxes or selling more of its own debt. Economists call this ‘fiscal backing’ for the central bank. In either case, the government is taking money out of the system on the central bank’s behalf. So the nightmare that makes helicopter money taboo is that the government refuses to do this. [1] ...

After explaining, he concludes

So this nightmare that makes helicopter money taboo is as unrealistic as most nightmares. The really strange thing is that ICBs have already had to confront this nightmare. It is more than possible that when central banks sell back their QE assets, they will make a loss, and so will be faced with exactly the same problem as with helicopter money. [3] A central banker knows better than not to worry about something because it might not happen. So the nightmare has already been faced down. It therefore seems doubly strange that the taboo about helicopter money remains. ...

Greece Did OK: Now that the dust has settled a bit, we can look calmly at the deal — if it really is a deal that survives through tomorrow, which some people doubt. And it’s increasingly clear that Greece came out in significantly better shape, at least for now.

The main action, always, involves the Greek primary surplus — how much more will they need to raise in revenue than they can spend on things other than interest? The question these past few days would be whether the Greeks would be forced into agreeing to aim for very high primary surpluses under the threat of being pushed into immediate crisis. And they weren’t. ...

Right now, Greece has avoided a credit cutoff, and worse yet an ECB move to pull the plug on its banks, and it has done so while getting the 2015 primary surplus target effectively waived.

The next step will come four months from now, when Greece makes its serious pitch for lower surpluses in future years. We don’t know how that will go. But nothing that just happened weakens the Greek position in that future round. ...

So Greece has won relaxed conditions for this year, and breathing room in the run-up to the bigger fight ahead. Could be worse.

Saturday, February 21, 2015

Faster Real GDP Growth during Recoveries Tends To Be Associated with Growth of Jobs in “Low-Paying” Industries, by Kevin L. Kliesen and Lowell R. Ricketts: Typically, deep recessions are followed by rapid growth. However, since the second quarter of 2009, when the latest recession officially ended, real (inflation- adjusted) gross domestic product (GDP) has increased at only a 2.3 percent annual rate.1 Prior to the latest recession, the economy’s long-term growth rate of real potential GDP was about 3 percent per year.2 Thus, the current business expansion could not only be the weakest on record—although that conclusion will ultimately depend on its length and future growth—but it could signal a worrisome downshift in the economy’s long- term growth rate of real potential GDP.

A common refrain among many economic pundits and analysts is that the bulk of the job gains during this recovery have been in “low-wage jobs,” a term that is rarely defined. This essay will explicitly define “low-wage” jobs in order to assess the validity of this claim. (This essay will not delve into the numerous hypotheses that have been put forward to explain why the economy fell into a deep recession and why the current expansion’s growth rate has been so anemic. Interested readers should refer to those articles listed in the reference section.)

To preview our conclusion, we found that the percentage change in job losses during the latest recession was higher in “high- paying” private-sector industries—which we define as industries with above-average hourly earnings—than in low-paying sectors. Likewise, the percentage change in job gains during the recovery was also proportionately larger in high-paying industries. It should be pointed out, though, that the total number of jobs in low-paying industries exceeds the number of jobs in high-paying industries by nearly 70 percent. Thus, an equal percentage increase in jobs in both industries would generate much larger job gains in low-paying industries than in high-paying industries. We also found that the percentage change in job gains in low- paying industries was much stronger following the 1981-82 and 1990-91 recessions, which also happened to be periods of much stronger real GDP growth. ...

When Mexico privatized its Social Security system in 1997, it wanted to avoid a situation where people would make risky investments with their retirement accounts, In fact, the regulations that it set up were so tight that everyone was required to have essentially the same investment. Hastings writes:

"Mexico launched a fully-privatized defined contribution plan in 1997, with 17 participating fund managers which could compete to manage investors’ privatized social security accounts. Given the tight regulations on investment vehicles, fund managers each offered one, essentially homogenous investment product. Investors could choose which firm they wanted to have manage and invest — for a fee — their personal social security account. Despite the large number of competitors selling an essentially homogeneous product, management fees and fund manager profits were high."

Here's some evidence on the fees that emerged. The "initial load" is the amount of each deposit that is is immediately paid to the investment adviser. The "annual fee" is then paid each year on the balance in the account. As Hastings explains: "Fund managers charged an average load (a fee taken as a share of account contributions at the time of contribution) of 23 percent and an annual fee on assets under management of 0.63 percent, implying that a 100-peso deposit earning a 5 percent annual real return would only be worth 95.4 pesos after five years." ...

Mr. Walker, in what was clearly a rite of passage into serious candidacy, spoke at a dinner at Manhattan’s “21” Club hosted by the three most prominent supply-siders: Art Laffer...; Larry Kudlow...; and Stephen Moore... Politico pointed out that Rick Perry, the former governor of Texas, attended a similar event last month. Clearly, to be a Republican contender you have to court the powerful charlatan caucus.

So a doctrine that even Republican economists consider dangerous nonsense has become party orthodoxy. And what makes this political triumph especially remarkable is that it comes just as the doctrine’s high priests have been setting new standards for utter, epic predictive failure.

I’m not talking about the fact that supply-siders didn’t see the crisis coming,... the people Mr. Walker was courting have spent years warning about the wrong things. “Get ready for inflation and higher interest rates” was the title of a June 2009 op-ed ... by Mr. Laffer; what followed were the lowest inflation in two generations and the lowest interest rates in history. Mr. Kudlow and Mr. Moore both predicted 1970s-style stagflation. ...

So what does it say about the current state of the G.O.P. that discussion of economic policy is now monopolized by people who have been wrong about everything, have learned nothing from the experience, and can’t even get their numbers straight?

The ... modern American right seems to have abandoned the idea that there is an objective reality out there... What are you going to believe, right-wing doctrine or your own lying eyes? These days, the doctrine wins.

Look at another issue, health reform. ... Then there’s foreign policy. ... And don’t get me started on climate change.

Along with this denial of reality comes an absence of personal accountability. If anything, alleged experts seem to get points by showing that they’re willing to keep saying the same things no matter how embarrassingly wrong they’ve been in the past.

But let’s go back to those economic charlatans and cranks: Clearly, failure has only made them stronger, and now they are political kingmakers. Be very, very afraid.

Thursday, February 19, 2015

Today’s Economic History: 1870 as the Inflection Point in Trade and Transport: ... The old rule-of-thumb before the railroad was that you simply could not transport agricultural goods more than 100 miles by land. Over that distance the horses or the oxen would have eaten as much as they could have pulled. Either find a navigable watercourse—and it had better be much closer than 100 miles—or find yourself stuck in self-sufficiency for anything other than small and light preciosities...

The coming of steam coupled with the metallurgy to cheaply make the rails and the engines of the railroad made a difference. It made transport over land wherever the rails ran as cheap as travel up navigable watercourses or across the oceans had ever been. It made it much faster as well. This was a big difference for people who wanted to move about. The was a big difference for spoilable or time-sensitive goods. This was not much of a difference for durable staples over routes that had been and still could be travelled by water. And since most people had for good reason settled near the water routes, the railroad was a very welcome boost, but not that much more. For the rise of Mexico City—with no water routes to the coasts and thus the world economy—the railroad was a game-change. But for the rise of New York City the game-change was not the Iron Horse but rather the Erie Canal.

The true revolution in transportation? The one that mattered for everyone? That came not in the 1830s with the railroad. That came later: it was the iron-hulled ocean-going coal-fired steamship.

It was the year 1870 that saw the Harland and Wolff shipyard of Belfast in northern Ireland launch the iron-hulled (rather than wooden-hulled), steam-powered (rather than wind-powered, but it did still have masts and sails), screw-propellered (rather than paddle-wheeled), passenger steamship the R.M.S. Oceanic. It took 9 days from Liverpool to New York, a journey that in 1800 would have taken more like a month. Its crew of 150 supported 1,000 third-class passengers at a cost of £3–$15–for a third-class passenger. Third class on the Oceanic cost half as much as passage a generation earlier during the Irish Potato Famine had. It coast roughly a fourth as much as in 1800. ...

The falling cost of transporting people marched alongside a falling cost of transporting goods. Food that cost 1.5 cents per pound more in London than in New York in 1840 cost only 0.5 cents per pound more after 1870 . This was a fall in the price of carrying the raw materials for a loaf of bread across the Atlantic. What had cost the equivalent of 30 minutes’ worth of unskilled labor time in 1840 cost less than ten minutes’ worth come 1870. After 1870 every commodity that was neither exceptionally fragile nor spoilable could be carried from port to port across oceans for less than it cost to move it within any country.

All this mattered for two reasons.

First, it meant that everyplace in the world was, as long as there were connecting harbors, docks, and railroads, cheek-by-jowl to every other place, economically. Everyone’s economic opportunities and constraints depended on what was going on across the globe. This had not been true before. Before just the consumption patterns of the elite depended on what was going on in other countries and on other continents.

Second, wherever you could cheaply move goods in mass you could move other things. Most particularly, you could also move and supply armies. Thus conquest—or at least invasion and devastation—became things that nearly any European power could undertake in nearly any corner of the world.

The Upside of Waiting in Line, by Tyler Cowen: Waiting in line got a bad rap as an ever-present part of the Communist Soviet Union. It could turn out to be a big part of America’s urban future, because some lines are actually useful. ...

Should the US Switch to a Declining Discount Rate?: Imagine that that you can save 100 lives by enacting one of two regulatory policies. The policies have the same cost, which must be paid right now. However, one of the regulatory policies saves the 100 lives in the present, while the other saves 100 lives 50 years from now. In this hypothetical example, the two policies are equal in their costs. Are the policies equal in their benefits, because both policies save 100 lives? Or does saving 100 lives in the present have a different value--a greater value--than saving 100 lives in the future?

This question involves what economists call the "discount rate," which expresses how much future benefits should be "discounted" compared to present benefits of the same size. If your answer to the hypothetical question is that saving the 100 lives 50 years from now has the same value as saving 100 lives right now, you are applying a discount rate of 0%--that is, benefits in the future are not discounted relative to benefits in the present. If your answer is that saving 100 lives now is a greater benefit than saving 100 lives 50 years from now, you are applying a positive discount rate.

Almost all economists argue that a positive discount rate is appropriate. At an intuitive level, having a benefit happen sooner is worth something. Also, there is a level of certainty in saving 100 lives right now, while saving 100 lives in 50 years has some degree of uncertainty as to whether that will happen. In addition, say that the hypothetical example would cost $1 billion in the present. If you invested that money in a safe financial that pays 3% per year, then after 50 years of compound interest it would add up to $4.38 billion--which makes the cost-benefit tradeoff 50 years from now look less attractive. A discount rate of zero would mean that we treat all costs and benefits as equivalent, no matter whether they occur in the present, the near-future, the middle-future, or the unimaginably distant future. Thus, the near-certainty of a large asteroid hitting the earth in the next few million years would be treated as of equal concern to if we could see the asteroid coming and the event was 10 years away--because the future isn't discounted.

But what should the discount rate be? And should the discount rate be a constant value over time, or a declining value over time? Consider what's at stake here. A higher discount rate means that we have more of an orientation to the present, and in particular will treat future benefits as much less important. A lower discount rate means that while we still have an orientation to the present, we are giving greater weight to what happens in the future. For public policy issues that involve spending resources now for a benefit that would occur (at least partly) in the distant future, like some of the risks of climate change, or the chance of an asteroid hitting the earth, it turns out that the choice of discount rate is extremely important.

In the United States, however, the Office of Management and Budget (OMB) recommends that project costs and benefits be discounted at a constant exponential rate (which, other things equal, assigns a lower weight to future benefits and costs than a declining rate), although a lower constant rate may be used for projects that affect future generations. ... For intragenerational projects, the OMB (2003) recommends that benefit-cost analyses be performed using a discount rate of 7 percent, representing the pretax real return on private investments, and also a discount rate of 3 percent, representing the “social rate of time preference.

Two points are worth noticing here. First, the U.S. policy has a fixed discount rate over time. Second, the difference between a 7% rate and a 3% discount rate over a long period of time like a century is enormous. Consider a policy that has a benefit of $100 billion that occurs 100 years in the future. At a discount rate of 7%, it is worth spending $115 million or less in the present to achieve that benefit. (Sometimes it's useful to think of this calculation in reverse: If you invested $115 million at a 7% annual interest rate, you would have approximately $100 billion at the end of a century.) At an annual discount rate of 3% of annual rate it would be worth spending up to $5.2 billion in the present to achieve that benefit. Thus, one of the differences between those who would spend many billions of dollars in the present to reduce the risks of climate change in the decades and centuries ahead, and those who would spend only millions of dollars, can be traced to different discount rates.

But what about other countries? The authors write (citations omitted):

In evaluating public projects, France and the United Kingdom use discount rate schedules in which the discount rate applied today to benefits and costs occurring in the future declines over time. That is, the rate used today to discount benefits from year 200 to year 100 is lower than the rate used to discount benefits in year 100 to the present.

They argue that after taking issues into account like uncertainty about the future, and the fact that the path of benefits recognized in the future will tend to follow a correlated pattern (rather than being random from year to year), a declining discount rate makes sense. You can check the articles for some ways in which such a rate could be estimated from data, but in practice, the decision of what rate to use may be guided by such studies, while ultimately being chosen by a regulator. They conclude:

We have argued that theory provides compelling arguments for using a declining certainty equivalent discount rate. ... Clearly, policymakers should use careful judgment in estimating a DDR [declining discount rate] schedule, whichever approach is used. Moreover, as emphasized earlier, the DDR schedule should be updated as time passes and more data become available. Establishing a procedure for estimating a DDR for project analysis would be an improvement over the OMB’s current practice of recommending fixed discount rates that are rarely updated.

Wednesday, February 18, 2015

Participants discussed considerations related to the choice of the appropriate timing of the initial firming in monetary policy and pace of subsequent rate increases. Ahead of this discussion, the staff gave a presentation that outlined some of the key issues likely to be involved...

The debate sounds familiar. On one side are those concerned that the Fed's zero rate policy will overstay its welcome:

Several participants noted that a late departure could result in the stance of monetary policy becoming excessively accommodative, leading to undesirably high inflation. It was also suggested that maintaining the federal funds rate at its effective lower bound for an extended period or raising it rapidly, if that proved necessary, could adversely affect financial stability...

while on the other side doesn't want to pull the trigger too early:

In connection with the risks associated with an early start to policy normalization, many participants observed that a premature increase in rates might damp the apparent solid recovery in real activity and labor market conditions, undermining progress toward the Committee's objectives of maximum employment and 2 percent inflation. In addition, an earlier tightening would increase the likelihood that the Committee might be forced by adverse economic outcomes to return the federal funds rate to its effective lower bound.

I would say that "many" is greater than "several," which means that as of January, the consensus leaned toward later than sooner. Indeed:

Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time...

Here it would be helpful to know the expected time horizons. How long is a "longer" time? My sense is that the possibility of a March hike was on the table at the request of the hawks, and "longer" meant sometime after March. But when after March? That is data dependent, but the Fed is challenged to describe exactly what conditions need to be met before justifying a rate hike:

Participants discussed the economic conditions that they anticipate will prevail at the time they expect it will be appropriate to begin normalizing policy. There was wide agreement that it would be difficult to specify in advance an exhaustive list of economic indicators and the values that these indicators would need to take.

Still, they have some broad guidelines:

Nonetheless, a number of participants suggested that they would need to see further improvement in labor market conditions and data pointing to continued growth in real activity at a pace sufficient to support additional labor market gains before beginning policy normalization. Many participants indicated that such economic conditions would help bolster their confidence in the likelihood of inflation moving toward the Committee's 2 percent objective after the transitory effects of lower energy prices and other factors dissipate.

It seems then that "many" participants are focused primarily on the labor market. It would be interesting to see how "many" of those "many" saw their confidence increase after the positive January numbers. Others pointed to inflation measures and wages as important indicators:

Some participants noted that their confidence in inflation returning to 2 percent would also be bolstered by stable or rising levels of core PCE inflation, or of alternative series, such as trimmed mean or median measures of inflation. A number of participants emphasized that they would need to see either an increase in market-based measures of inflation compensation or evidence that continued low readings on these measures did not constitute grounds for concern. Several participants indicated that signs of improvements in labor compensation would be an important signal, while a few others deemphasized the value of labor compensation data for judging incipient inflation pressures in light of the loose short-run empirical connection between wage and price inflation.

My take is this: To get a reasonably sized consensus to support a rate hike, two conditions need to be met. One is sufficient progress toward full-employment with the expectation of further progress. I think that condition has already been met. The second condition is confidence that inflation will indeed trend toward target. That condition has not been met. To meet that condition requires at least one of the following sub-conditions: Rising core-inflation, rising market-based measures of inflation compensation, or accelerating wage growth. If any were to occur before June, I suspect it would be the accelerating wage growth.

On communication, the Fed sees that is has trapped itself:

Participants discussed the communications challenges associated with signaling, when it becomes appropriate to do so, that policy normalization is likely to begin relatively soon while remaining clear that the Committee's actions would depend on incoming data. Many participants regarded dropping the "patient" language in the statement, whenever that might occur, as risking a shift in market expectations for the beginning of policy firming toward an unduly narrow range of dates. As a result, some expressed the concern that financial markets might overreact, resulting in undesirably tight financial conditions.

If "patient" means exactly two meetings as is widely believed, then why would dropping patient imply higher rates in an "unduly narrow range of dates"? Isn't "two" two? If "two" is two, why the need for the adjective "unduly"? The definition of "unduly" according to the dictionary is:

to an extreme, unreasonable, or unnecessary degree

So "two" is thus extreme or unreasonable? Either "two" isn't two or patient wasn't meant to imply always two meetings. Indeed, Cleveland Federal Reserve President Loretta Mester suggests that "two" is only one interpretation. Via the Wall Street Journal:

WSJ: When you say that, do you have April in mind or do you have June in mind?

MESTER: Given what we’ve communicated, June is a viable date. We have the patient language which has been interpreted as two meetings.

The language "has been interpreted" not "means" two meetings. If "two" is plainly two, how can it have any other interpretation? And "has been interpreted" by whom, for that matter?

You get the point. The Fed can't keep itself from making calendar dependent statements, and thus undermines it's own communications. Yellen should have said "patient" means "until the data says otherwise." But she couldn't help herself by not including some kind of calendar dependent qualifier. As a consequence, now the Fed is stuck with modifying the language to keep a June rate hike on the table.

Wait, is a June rate hike still on the table? Although the minutes were interpreted dovishly by financial market participants, I doubt the Fed will want to pull the plug on June just yet. Incoming Fed speak continues to signal a rate hike is coming (including Mester describing June as a "viable option" this week), the January labor report was solid, via the minutes the Fed sees external risks as dissipating, we have four more employment reports before the June meeting, and I doubt the Fed really wants to start signaling policy two periods in advance. Too early to pull June off the table, but they can't move in June without something solid on the inflation front. So the March statement, or subsequent press conference, will be about dealing with the "patient" language, and the April meeting will be about whether they really expect to move in June or not.

One more consideration. It has been noted that the length of the minutes ballooned in January. Less noted is that the FOMC has a new secretary, Thomas Laubach, who succeeds William English. The additional detail may reflect that change, and the additional detail may swing our interpretation of the minutes relative to past minutes.

Bottom Line: The Fed is plainly focused on raising rates. As a group, they sense the time is coming to begin policy normalization. But they don't yet know when exactly that time will be. They don't yet have everything they need to begin, and they don't know when they will have everything (which is why they need to end calendar-dependent language). We know not yet. June? Maybe, maybe not.

Basic personality changes linked to unemployment: Unemployment can change peoples' core personalities, making some less conscientious, agreeable and open, which may make it difficult for them to find new jobs, according to research published by the American Psychological Association.

"The results challenge the idea that our personalities are 'fixed' and show that the effects of external factors such as unemployment can have large impacts on our basic personality," said Christopher J. Boyce, PhD, of the University of Stirling in the United Kingdom. "This indicates that unemployment has wider psychological implications than previously thought." ...

The study suggests that the effect of unemployment across society is more than just an economic concern -- the unemployed may be unfairly stigmatized as a result of unavoidable personality change, potentially creating a downward cycle of difficulty in the labor market, Boyce said.

"Public policy therefore has a key role to play in preventing adverse personality change in society through both lower unemployment rates and offering greater support for the unemployed," Boyce said. "Policies to reduce unemployment are therefore vital not only to protect the economy but also to enable positive personality growth in individuals."